A Rational Foundation for Trend-Chasing and Contrarian Trades with Implications for Momentum Anomalies

Quarterly Journal of Finance, 3, 1-20

33 Pages Posted: 29 Mar 2005 Last revised: 9 Feb 2018

See all articles by Haim Kedar-Levy

Haim Kedar-Levy

Ben Gurion University of the Negev - Guilford Glazer Faculty of Business and Management

Date Written: January 3, 2013

Abstract

Trend-chasing and Contrarian are well-documented empirical trading ‎patterns that the literature generally attributes to behavioral biases. In ‎contrast, we argue that both are rational portfolio rebalancing strategies in ‎a dynamic asset allocation framework. Analyzing the interactions between ‎strategies implemented in stocks and bonds, we find that a key parameter is ‎the investor’s level of relative-risk-aversion vs. the market price of risk. ‎Our mapping of preferences to trades fits remarkably well recent empirical ‎findings of time-series momentum and reversal. Specifically, speculators ‎trade like Trend-chasers throughout the momentum phase closing positions ‎once the trend reverses, while hedgers trade like Contrarians. These trades ‎seem to explain time-series momentum. ‎

Keywords: Trend-chasing, Contrarian, Rational, Behavioral

JEL Classification: G11, G12

Suggested Citation

Kedar-Levy, Haim, A Rational Foundation for Trend-Chasing and Contrarian Trades with Implications for Momentum Anomalies (January 3, 2013). Quarterly Journal of Finance, 3, 1-20, Available at SSRN: https://ssrn.com/abstract=678764 or http://dx.doi.org/10.2139/ssrn.678764

Haim Kedar-Levy (Contact Author)

Ben Gurion University of the Negev - Guilford Glazer Faculty of Business and Management ( email )

P.O. Box 653
Beer-Sheva 84105
Israel
(972) 8 6472569 (Phone)
(972) 8 6477697 (Fax)

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